Q&A: Amundi’s James Kwok on currency risk

Are we entering a particularly volatile time in currency risk management?Investors have become used to a period of diversification away from the US dollar and have favoured higher yielding foreign currencies for some time. The reason for this sustained period of dollar weakness was, firstly, the US current account deficit and secondly, the large amount of quantitative easing undertaken by the Federal Reserve Bank. So investors sold the dollar and bought foreign currencies but as the US economy began to improve, the dollar strengthened and investors found themselves overweight risky foreign currencies and underweight a healthier looking dollar. This has prompted a huge rebalancing exercise among investors now looking to hedge away some of the risk in their portfolios that is creating sustained volatility in the markets. The weak dollar mind-set has been here for around a decade, so the unwinding, or rebalancing, is going to take some time.

Can you give us any examples of specific risks you see in the market?There has been a strong belief that energy prices will remain high and that demand for renewable energy will remain high in emerging markets. A significant number of projects have been financed with the US dollar, based on that belief. If we see falling oil prices and a slowdown in demand for renewable energy at the same time as a recovering US dollar, that could be a perfect storm for some of the corporates who have bet long on renewable energy financed by dollar investment.

What do local government pension fund managers need to weigh up when considering currency hedging?Typically investors have global portfolios these days and through their global equity mandates will have exposures to foreign currencies. Sometimes their stocks may be performing very well but, taking the example of the Euro today, if the currency is being devalued then even though the stock is doing well, the global value of the investment will suffer compared to Sterling. Investors need to understand the correlation between an asset and its currency; they don’t always behave in the same way. If you understand how a stock performs in relation to its currency, you can take more informed hedging decisions. You also need to think about value. Determining whether a currency is under or overvalued will help decisions about how much of that currency you will want to own. You can arrive at your valuation in a number of different ways, there are various methodologies such as purchasing power parity, for example. But the further away a currency gets from what you believe is fair value, the more confident you can be in getting a return on owning, or shorting that currency.

When you see clients’ portfolios for the first time, are they often running more currency risk than they need to be?Without question. And there’s good reason for that. Pensions CIOs are often well trained and focused on managing asset classes. So they understand equities and fixed income inside and out but they won’t necessarily have as developed an understanding of how currency risk affects their portfolios. For example, there’s no academic research to support the idea that a growing economy will necessarily have a strong currency but investment managers are naturally drawn towards growing economies. Quite rightly so but there are currency risk implications to consider that can be managed.

What is meant by active and passive overlay?Investment managers with less experience of currency risk management tend to opt for passive hedging. In this instance the client sets a hedging ratio with us of say 50%, for example, and then we make the relevant trades. As clients become more comfortable with the world of currency and currency risk management, they can opt to give us more discretion over the trades we make, in line with some agreed objectives. Active overlay might include more trades which are designed not just to hedge out risk but also to take advantage of opportunities we see in the market.

Register for the Room 151 Weekly Email Digest

Latest tweets

LGPS reports bumper average return of 21.4%: Local Government Pension Scheme (LGPS) funds produced an average 21.4% return on their investments last year, with three quarters outperforming their benchmarks. The strong returns, revealed in the LGPS… dlvr.it/QTyvSk

Northants financial reporting ‘vague, inconsistent, unclear and lacking details’: Auditors say that the quality and transparency of financial reporting at Northamptonshire County Council has prevented effective decision making. In its interim audit… dlvr.it/QTykBC

LPGS pools urged to sign up to transparency code: A London borough’s pensions chief has called on all Local Government Pension Scheme pools to sign up to a new transparency code designed to help individual funds make better investments.[...] dlvr.it/QTyWyB

Conrad Hall: The lesson for LOBOs from backgammon: Calculating whether LOBOs are a good risk is controversial. Conrad Hall uses lessons drawn from the famous board game to help devise a plan for managing the controversial loans. LOBOs[...] dlvr.it/QTxyGJpic.twitter.com/7dqx6srYcl

Minister calls on LGPS pools to channel more investment into housing: Local government minister Rishi Sunak has encouraged Local Government Pension Scheme (LGPS) pools to increase their investment in housing. Speaking at the Pensions and Lifetime Savings… dlvr.it/QTpDhNpic.twitter.com/01WSmF3lQa

Clive Heaphy: My first 100 days as CFO at Birmingham City Council: Birmingham’s troubles are well publicised. A little more than three months ago Clive Heaphy took on the job of running the finance department at the city’s council. Here he reveals[...] dlvr.it/QThGNSpic.twitter.com/fsdI5cjlUG

Basingstoke builds housing into investment strategy: A home counties borough council has agreed to amend its property investment strategy to include residential developments. In February, Basingstoke Borough Council approved plans to boost its strategy… dlvr.it/QTBNYl

Board moves to end auditor confusion over LOBOs: Guidance introduced last year on how councils should account for controversial Lender Option Borrower Option (LOBO) loans has been clarified after causing confusion among auditors. A group of audit… dlvr.it/QTB1NF

MPs propose a ban on councils borrowing for commercial property investment: A bill to ban councils borrowing from central government for commercial property investment is to be considered by the House of Commons. Christopher Chope, Conservative MP for… dlvr.it/QT9qnFpic.twitter.com/MGtLH3KVQy

Archives

We use cookies to ensure that we give you the best experience on our website. If you continue without changing your settings, we'll assume that you are happy to receive all cookies from this website.OK